Business rescue curbs up for debate
Master agreements put forward as another exception to interference by the powers of rescue practitioners
BUSINESS rescue practitioners have far-reaching powers to cancel or suspend any provision of an agreement to which a company in financial distress is a party.
One exception to this rule is an agreement of employment.
In our view a second exception is master agreements as contemplated in section 35B and exchange traded derivatives that fall within section 35A of the Insolvency Act, 1936.
We believe that it must have been the intention of the legislature that these transactions — such as trades under a master agreement, like the 2002 ISDA (International Swaps and Derivatives Association Inc) — are to be safe from suspension or cancellation during business rescue proceedings.
This is a controversial issue as the section in the new Companies Act, 2008 is not as precise as it could be. As it stands, the issue is subject to debate and the legislation may yet be amended. Section 136(2) of the 2008 Companies Act, says:
“Subject to sections 35A and 35B of the Insolvency Act, 1936 … despite any provision of an agreement to the contrary, during business rescue proceed- ings, the practitioner may cancel or suspend entirely, partially or conditionally any provision of an agreement to which the company is a party at the commencement of the business rescue period, other than an agreement of employment.”
When section 35B of the Insolvency Act was amended in March 2005, the effect was to preserve pre-and postinsolvency netting and set off provisions contained in the master agreements which govern over-the-counter derivative transactions in SA.
Section 35B carves out the derivative transactions executed under these master agreements so that any netting which had taken place pre-insolvency would not be subject to the Insolvency Act’s provisions relating to voidable dispositions, voidable preferences and undue preferences.
The liquidator would have to abide by the netting and set off provisions of the master agreements. Further, upon insolvency, all unperformed obligations under the master agreements terminate automatically, the values of the unperformed obligations are determined at market value and set off, and a net amount is payable.
Similarly, section 35A preserves all pre-insolvency set-off, netting and close-outs of positions concluded on a stock exchange in terms of the rules of that exchange, and all such set-offs, netting and close-outs are binding on a liquidator upon insolvency. Why the debate? The provisions in the new Companies Act provide that the rights of the business rescue practitioner may only be exercised during business rescue proceedings. By citing sections of the Insolvency Act in the clause dealing with business rescue, the distinction between liquidation and pre-insolvency proceedings such as business rescue, becomes somewhat blurred.
The anomaly is that business rescue proceedings (which are aimed at rescuing the company on a solvent basis) must first have failed in order for the provisions of the Insolvency Act to become relevant.
Some argue that the new Compa- nies Act therefore trumps the Insolvency Act and that those parties concluding derivative transactions on exchange or under the master agreements are at risk should their counterparty enter into business rescue proceedings, as the practitioner may set aside, cancel or suspend any provisions of the master agreements or any transactions concluded on exchange.
The concern is that the business rescue practitioner would be able to decide which open positions to close out and which obligations to abide by, to cancel or to suspend depending on whether the market has moved in favour of or against the financially distressed company.
The fear is that “cherry-picking” by the practitioner would lead to increased systemic market risk. One can imagine the resultant consequences if trades executed on the Derivatives Division of the JSE by a company which enters into business rescue proceedings become unenforceable at the sole discretion of a business rescue practitioner. The same market upheaval would take place in the over-thecounter market.
We are of the view that despite the anomaly and debate created by the current wording of section 136(2) of the 2008 Companies Act, the inclusion of the words “subject to section 35A and 35B of the Insolvency Act” can only mean that the master agreements contemplated by those sections and the transactions concluded on exchange should benefit from the effect of section 35A and section 35B and should be excluded from the business rescue practitioner’s far-reaching powers.
The same conclusions apply to repurchase and reverse repurchase transactions concluded under the GMRA (Global Master Repurchase Agreement) and securities lending transactions concluded and under the GMSLA (Global Master Securities Lending Agreement).
We are of the view that the intention of the legislature was to exclude master agreements and the corresponding collateral arrangements from the business rescue practitioners’ powers and to preserve the provisions of the master agreements and the trades concluded on exchange despite one party becoming financially distressed and subject to business rescue proceedings. There will hopefully be some clarifying amendments in the much anticipated Amendment Act.
Either way, the integrity of the preand post-insolvency netting provisions of the master agreements such as the ISDA, GMRA and GMSLA are preserved, and trades concluded on exchanges will still be closed out and netted according to the rules of that exchange.
By citing sections of the Insolvency Act in the clause dealing with business rescue, the distinction between liquidation and pre-insolvency proceedings such as business rescue, becomes somewhat blurred The anomaly is that business rescue proceedings...